Car finance jargon explained and the small print to look out for

Car finance jargon explained and the small print to look out for

Matt Allan

Published:4:00 pmMay 23, 2019

It’s easy to get carried away when buying a car. It looks amazing, you can see yourself clocking up the miles touring around the country on road trips, but picking the car is the fun bit, the more serious bit is – how are you going to pay for it?

Unless you’re lucky enough to have enough savings to cover the full cost of the car upfront, you may want to consider finance to help you spread the cost over more manageable instalments.

To help guide you through this potential minefield we’ve spoken to James Fairclough, CEO of AA Cars to examine the different types of finance packages and clarify some of the confusing jargon around them.

Types of finance

There’s a lot to get your head around when considering car finance. (Picture: Shutterstock)

Firstly, you need to be aware of the finance products that are available, what you are signing up to, and the options that are available to you at the end of the payment period.

Depending on how long you want to keep the car for – 6 months, 3 years, indefinitely? – will play a big role in deciding which car finance option is best for you. The four main forms of car finance are:

Hire-Purchase (HP)
Involves paying a deposit up front, followed by fixed monthly payments. The lender owns the car up until the final payment is made (including the ‘option to purchase’ fee, which is usually a couple of hundred pounds) and it is only then that the ownership of the vehicle transfers to you.

Personal Contract Purchase (PCP)
Like an HP deal, PCP car finance deals require the borrower to pay a deposit and fixed repayments each month over the course of 1-4 years. At the end of the term, you can either pay a “balloon payment” to keep the car, trade it in for an upgrade or return it to the dealer.

Personal Leasing (PCH)
This is also called contract hire (PCH) and is similar to PCP car finance. The main difference with this type of car finance is that you’ll never own the car yourself. You are, for all intents and purposes, renting the car for a set period with an agreed annual mileage.

Unsecured Loan
A bank or other lender will offer a sum of money which can be used solely for buying a vehicle. The money is paid back over an agreed period, usually by direct debit, with interest added on top of the amount you borrowed. The interest rate is usually fixed at the start of the loan.

Jargon buster

Annual percentage rate (APR)
You should check the annual percentage rate (APR), which includes the interest rate plus any other lender charges. The larger your deposit, the lower the interest rate is likely to be. You should also try to avoid being influenced by low monthly payments that could, in fact, be a more expensive option when considering the total amount repayable.

Mileage limit
The majority of car finance contracts include a mileage restriction as it is one of the main elements that will affect the resale value of the vehicle. If you exceed the mileage cap, it can be very costly. Some car finance providers charge up to 5p a mile.

Racking up too many miles could see you hit with significant extra charges. (Picture: Shuttestock)

Fair wear and tear
Another factor to keep an eye out for is fair wear and tear. “Fair” wear and tear refers to the natural deterioration of a vehicle as a result of day-to-day use. Common issues that are unlikely to be considered as fair wear and tear include scratches on paintwork, dents on the bodywork, damage to the wheels and trims, and rips or tears to the upholstery or carpets. If any of these problems are found at the end of the contract period, you may be liable to penalty charges. It is worth asking your finance provider for a more detailed list of what they do and don’t consider to be fair wear and tear to avoid any disagreements at the end of the contract period.

Length of payment period
You should also consider the length of the payment period. Although longer term loans may be enticing because of their lower monthly repayments, they generally come with increased interest so will end up costing you more in the long run. Most people find between two and five years to be a comfortable repayment period.

Guaranteed future value (GFV)
If you intend to buy the car when the contract is up, it is essential that you look out for the guaranteed future value. The is the expected value of the car at the end of the contract, at which point you can decide whether you wish to take ownership of the vehicle. It is calculated by taking into account various factors, including depreciation, mileage and condition. It is agreed between both parties at the start of the contract and will not change regardless of true depreciation and the current market value of the car at the end of the contract. This guarantee helps to minimise the risk of depreciation, so if the value of your vehicle drops more than predicted, the finance provider will bear the cost burden.

Check what your lender considers to be fair wear and tear. (Picture: Shutterstock)

Add-ons
Finally, you should keep an eye out for add-ons. Car finance deals can come with perks included. While it’s best to objectively weigh up whether the provider is factoring these add-ons into the overall cost they are charging for the car, lots of providers incentivise finance products with the likes of six months’ free road tax, pre-sale vehicle inspections, or a year’s worth of free car servicing.

Tips for finding the best car finance deals

Online comparison websites
Like everything money-related, one way of sourcing the best car finance deals is by using a comparison website. The aim of these sites is to show the best car finance rates based on the details you provide – including secured loans, hire purchase deals and personal contract purchases. While they’re a useful starting point, bear in mind that not all providers are included, so there’s a chance the best car finance deals shown aren’t necessarily the best available to you.

Dealer finance
If you are buying your car from a reputable dealer, you may be offered finance at the point of purchase. Unlike a car loan, the repayment term of car dealer finance is typically three years. One thing to bear in mind with dealer finance is how big the deposit and monthly payments are. An appealing car interest rate isn’t much use if you’re going to struggle to meet the payments.

You can arrange finance through a dealer but it’s not the only option. (Picture: Shutterstock)

Going direct
Sometimes going direct is best. It’s in a provider’s power to give you a bespoke quote that reflects your personal situation – and offer tailor-made terms that work out better in the long-term. Applying directly through a service such as AA Car Finance, they will use your details, budget and/or what car you’re looking at to match you with the car finance options available to you.

Be cautious of 0% loans

When shopping for a car, you’ll probably see a lot of low-interest special offers and incentives to entice you to buy. Many car finance providers offer 0 per cent finance deals, which seem great on the surface, but these packages usually involve a large deposit upfront, which most people cannot afford.

Also, many of these 0 per cent deals may only apply to a very specific model or an older model that a dealer is finding hard to sell. It’s worth asking the dealer if the model you’re interested in qualifies for the deal. Some sellers may offer a 0 epr cent deal on vehicles that are priced higher to compensate for the low interest rate, so make sure you shop around and check prices elsewhere before signing your name to anything.

An attractive 0% loan might be offered to get you into an older car or help a dealer shift a backlog of a particular model. (Picture: Shuttestock)

Does shopping around for car finance ruin your credit score?

One thing to be wary of when shopping around for car finance is how your credit score might be affected. Repeatedly getting quotes for loans and other finance deals can leave a ‘footprint’ that can negatively impact your credit score. However, there are some providers and brokers that carry out ‘soft checks’ on your credit history which won’t affect your score. These can give you an indicative rate – based on the amount you want to borrow and your credit history but won’t impact your credit score or leave a mark on your file. If you choose to apply for a loan once you’ve completed the eligibility check, a hard credit search is run, which will appear on your file.